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What’s Next for the FX Lawsuits Against State Street and Bank of New York?

Although it didn’t make the headlines last week, State Street suffered a setback in its long-running legal dispute over the fees it charges clients for foreign exchange services when a District Court judge in Boston denied its motion to dismiss the suit.

State pension funds in Arkansas and California have sued State Street, alleging that they were for years systematically overcharged by the bank for foreign exchange transactions.

State Street has not set aside a reserve against potential claims in these cases, according to a regulatory filing, and its public statements indicate it will contest the lawsuits. It also has said that the outcome of these suits could have a “material adverse effect” on its future financial results.

This issue also dogs Bank of New York Mellon Corp., which is facing similar suits from state pension funds in Virginia and Florida. It reported a decline in first-quarter foreign exchange revenue of 21% versus a year ago, and in January settled with federal prosecutors, agreeing to amend its marketing material by eliminating the reference to providing “best execution” in foreign exchange.

Both banks are in a very tough spot. The outcome of a court trial is risky and would present sensitive bank documents for everyone to see. There are bound to be embarrassing emails and other material that the banks would not want revealed. Bank of New York in particular could face some very juicy evidence gathered by a whistle-blower.

But a settlement is also difficult without opening the door to further claims from clients or regulators, who, as State Street notes in its 10-K, are already taking a look at the matter:

“Since the commencement of the litigation in California, attorneys general and other governmental authorities from a number of jurisdictions, as well as U.S. Attorney’s offices, the U.S. Department of Labor and the Securities and Exchange Commission, have requested information or issued subpoenas in connection with inquiries into the pricing of our foreign exchange services. We continue to respond to such inquires and subpoenas.”

For both banks, the best way to end the litigation – and the uncertainty it creates for its clients and shareholders – is to reach a global settlement that addresses changes in business practices and monetary restitution. That will take leadership by their CEOs, but the alternative is months, perhaps years, of costly legal skirmishes in courtrooms around the country, while clients take their business elsewhere.

An aggressive settlement strategy, coupled with a credible communication plan, could bring this unpleasant story to a close.